What Is A Stock? What Is A Mutual Fund?

What Is A Stock?

If you and I start a company (oooh, can it be a shoe company?!), we have to find a way to tell who is the owner of the company. It could be half yours and half mine, but still that would have to be written down somewhere, and there would have to be a mechanism for changing that – if we needed to. However, if when we started the company, we needed to a) buy $50,000 worth of shoes as initial inventory, and b) have $10,000 in start-up costs (rent, cash register, etc.), our total required capital (the amount of $$ we would need to open) would be $60,000.

If you contributed $40,000 and I contributed $20,000, we might agree that you own 66.6% of the company, and I own 33.3%. Lawyers would help us sort it all out with the paperwork, but for simplicity sake, let’s say our company consisted of 300 shares (like a pie, with 300 pieces..). You would own 200 shares, and I would own 100 shares. Shares are also called stocks. If the name of our company was the Me&You Shoe Company, you would own 200 stocks of the Me&You Shoe Company.

Some companies have millions of shares (pieces of a single pie) and trade on a stock market, meaning you can buy them. So, yes, if you do buy 100 shares of AAPL-Q, you own a teeny, tiny piece of the company. Fun!

What Is A Mutual Fund?

A mutual fund is a group of stocks (or bonds, etc.) that you can buy as one single investment. For example, if you wanted to invest in the technology sector, instead of buying 100 shares of Apple or 100 shares of Google, you could buy a technology mutual fund that included a basket of technology stocks, including Apple, Google, Facebook, Twitter, Samsung, and many others. This is a much smarter decision because it spreads your risk over many stocks, instead of being concentrated in a single stock. This is called diversification.

Why don’t you just buy all 30 stocks in your account? You may want to do that when you are super wealthy (which will be awesome!) but you have to pay a commission every time you buy and sell a stock. And it is also easier and cheaper to purchase lots of 100. Meaning it is easier to purchase 100, 200 or 300 stocks of AAPL-Q than just 24 stocks. You can only imagine (well, we could calculate it, but let’s not) how much it would cost to purchase 100 each of 30 stocks. Plus commission on each when you buy and when you sell. Thus, the mutual fund was born. Allowing you to purchase exposure to 30+ stocks with little or no up-front fee.

There are additional (very important) issues relating to both stocks and mutual funds (fee structure, professional management, how they are priced, taxation, etc.) but for the purpose of this article, I simply wanted to provide a basic definition for each.

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